In the stock market, options come in a variety of forms, but there are primarily two kinds: call and put. But before we move on to types of stock options let’s have an overview of options.
What are the Options?
The option contract in derivatives is a financial product known as a derivative whose value is measured with the underlying assets, which are otherwise stocks, indexes, and exchange-traded funds (ETFs). An options contract gives the holder the ability to choose between buying or selling, which holds an important aspect. In contrast to futures, the holder does not have to perform the asset purchase/sale to realize a physical settlement.
Different Types of Options
1. Call Option
An options contract that grants the contract holder the right, but not the duty, to purchase the underlying asset connected at the strike price prior to or on the expiration date is known as a call option. When traders and investors believe that the price of the underlying shares will rise before the option expires, they purchase a call option on equities. In these situations, investors take advantage of the rise in share price by purchasing a long call option.
For instance, you may purchase an options contract at the strike price of 300 if you believe that the price of XYZ stock, which is currently trading at Rs 300, will rise to Rs 500 in a month. You turn a profit if the stock price hits INR 500 before the deadline. Nevertheless, you forfeit the premium—the amount you paid to purchase the options contract—if the stock price falls short of your target.
Call options often fall into two categories:
Long Call Option: In a long call option, the buyer is entitled to acquire the underlying asset at a certain price at a later time, but they are not required to.
Short Call Option: In a short call option, the seller commits to selling the underlying asset to the buyer at a certain price at a later time.
2. Put Option
The owner of a put option has the "right to sell." Throughout the expiration period, a put holder may sell as stock at the strike price. An investor places a put option when they anticipate a decline in market price in the future (a bear market). The put holder may exercise their right to sell the underlying asset at the strike price, which is higher than the market price at the time if the asset's price declines. The investor benefits as a result.
For instance, you may purchase a put option contract at the strike price of 300 if you believe that the price of XYZ stock will drop from INR 500 to INR 300 in a month. You turn a profit if the stock price hits INR 300 before the deadline. You incur a loss if the price rises over INR 300.
There are two types of put options. They are: -
Long Put Option: Under a long put option, the buyer is under no legal duty to acquire the underlying asset at the fixed price at a later date, but they do have the right to do so if they believe the price of the underlying asset will drop.
Short Call Option: A short call option holder agrees to sell the underlying asset to the put option buyer at a determined price on a picked date, assuming that the price of the underlying asset will increase.
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Types of Options Based on Underlying Security
Investors can purchase both types of options with their different underlying assets, the option contracts can be of different sorts. Here are the types of options based on underlying securities:
- Stock options
- Index options
- Futures options
- Currency options
- Commodity options
Types of Options Wholly Based on Expiration Cycle
The expiration cycle is the period within which the holder of the contract can execute the right to buy or sell the underlying asset. Options are also available with types that feature a fixed expiration cycle, whereas you can choose an expiration cycle for the options of other types.
Examples of 4 types of options based on the expiration cycle are listed below:
The Bottom Line
With relatively low initial investment, options are among the most beneficial trading instruments that can provide you with some of the biggest returns on the stock market. So, before you start trading these instruments, educate yourself on them and the risks involved.
